project

Dollops of discretion and self regulation punctuate the way real estate companies recognise revenues, placing a question mark over the accuracy of this headline number and making redundant any comparison across the peer set. For example, DLF, India’s largest real estate company, has a unique entry in its financial statements, ‘unbilled receivables’, that accounts for three fourths of its revenues. These are essentially revenues recognised by the company in excess of what is due from customers. In 2010-11, this accounted for Rs 7,200 crore of DLF’s total revenues of Rs 9,560 crore. The reason DLF and other real estate companies are able to claim what they are yet to receive is because of the revenue-recognition method they follow: the ‘percentage completion’ method. Under this, a builder recognises revenues not when a project is finished, but continuously, in proportion to the money spent by it on the project. So, in a given year, if a builder has spent 30% of the estimated cost of a project, it can recognise 30% revenues from it. Next year, if the spend increases to 50%, then it can recognise 20% more revenues, and so on. “This avoids spiking of revenues when the project gets completed,” says Ashok Tyagi, group chief financial officer of DLF. Now, this is where the discretion comes in. There are no standard rules on what constitutes cost or when revenues can begin to be recognised. There are also no certifiable independent checks on how much of a project has been completed. Tyagi says DLF uses surveyors to certify its project cost and architects the area. But institutional investors and observers don’t trust these notings. “Percentage of completion method is a leap of faith,” says N Venkatram, partner, Deloitte Haskins & Sells , an audit and advisory firm. “A lot of it is based on what other professionals certify.” The question of faith is pronounced in the current market situation, where projects are getting delayed and seeing cost overruns. According to PropEquity , a property research firm, nearly half of the 930,000 residential units under construction in the country due for delivery between 2011 and 2013 are likely to be delayed by up to 18 months. Companies are able to use the percentage of completion method to bolster their revenues. At the same time, since they are able to add incremental revenues from a project, they don’t have an incentive to meet their delivery commitments to customers. “This is one business (real estate) I cannot comprehend,” says the founder of a mid-sized investment bank, not wanting to be identified. DLF apart, other real estate majors like Unitech, Indiabulls, Sobha Developers, Puravankara and Parsvnath also follow the percentage of completion method. Sometimes with different outcomes. “We don’t have unbilled receivables,” says R Nagaraju, chief financial officer of Unitech, India’s second-largest real estate company. “Instead, we have customers paying in excess of what we have recognised under the percentage-completion method.” According to Nagaraju, in 2009-10, such customer advances amounted to around Rs 550 crore, nearly a fifth of its revenue. He declined to provide the latest numbers, saying it will be disclosed in the company’s 2010-11 annual report. Oberoi Realty is in a similar situation. For 2010-11, the company showed Rs 392 crore under ‘revenue in excess of billing’, accounting for 40% of its total revenues of Rs 984 crore. Saumil Daru, its chief financial officer, says: “We do not find merit in deferring income to the end of the project. It’s better to show income and profit periodically as they come. Being a listed company, we have to show our results on a quarterly basis.” Even as real estate companies stand united in vouching for the percentage-completion method, there are differences in the specifics they adopt. Two in particular: what all they include in the project cost and when they start recognising revenues from a project under construction. In the absence of statutory guidelines from the accounting regulator, companies use their own discretion. First, the project cost. Some companies (DLF) include both land and construction cost. Others ( Unitech and Oberoi) exclude the land cost and take only the construction cost. “Land for a real estate project is like steel in a motor car project. I see no reason why land should be excluded,” says Tyagi of DLF. Counters Daru of Oberoi: “A company’s cost goes up substantially in the first year. We avoid this.”